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What is Oil Speculation?

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  • Written By: Osmand Vitez
  • Edited By: C. Wilborn
  • Last Modified Date: 25 September 2016
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Oil is a commodity often traded on multiple exchanges around the world. This trading leads to oil speculation, which is buying and selling oil based on current events. As demand for oil naturally increases with the advancement of economies, investors can anticipate this demand and buy oil commodities. This drives up the price of oil, creating higher costs. Oil speculation also allows investors to buy or sell the commodity when negative information or events come to the marketplace.

Commodities often trade in futures contracts. Each contract specifies that the investor will receive a certain amount of the commodity at a specific date for an arranged price. The contracts represent the potential price increases or decreases an investor expects in the market at the date on the contract.

For example, barrels of oil may be trading currently at $50 U.S. Dollars (USD) a barrel. Investors believe the price per barrel of oil will increase to $70 USD in two months, based on oil speculation. An investor might purchase as many contracts as possible at $50 USD per barrel and sell once it reaches $60 USD. This creates a varying cost for oil-based products as speculators buy and sell the futures contracts on the open market.

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Oil speculation also leads investors to purchase more contracts when negative tensions enter the oil market. Disruptions in service from the Middle East oil-producing countries will often lead speculators to purchase more contracts. National events often lead oil prices to rise precipitously, leading to copious profits for the speculative investors. This will raise current prices of oil as few contracts are available. Future oil prices also increase as investors hold contracts for oil and companies will have to pay the price listed on the contract as no current oil contracts are available on the market.

Another reason for oil speculation is to hedge against future increases and decreases in a country's oil reserves. For example, when a country's reserves fall below the average amount needed to keep up with demand, speculators will enter the market and begin purchasing contracts. This leads to an increase in oil prices as demand will naturally drive up the price of oil. The opposite is true when oil reserves are higher than expected. Once the investor learns that oil reserves are high, the investor must sell his contracts to avoid taking losses from falling oil prices.

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